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What is an 'IPO Lock-Up'

An IPO lock-up, also referred to as "lock-up period," is a contractual caveat referring to a period of time after a company has initially gone public, usually between 90 to 180 days. During these initial days of trading, company insiders or those holding majority stakes in the company are forbidden to sell any of their shares. Once the lock-up period ends, most trading restrictions are removed.

BREAKING DOWN 'IPO Lock-Up'

An IPO lock-up is done so that the market is not flooded with too much supply of a company's stock too quickly. Typically, only 20% of the outstanding shares are initially offered to the investing public. A single large shareholder trying to unload all of his holdings in the first week of trading could send the stock downward to the detriment of all shareholders. Empirical evidence suggests that after the end of the lock-up period, stock prices experience a permanent drop of about 1-3%.

IPO lock-up periods allow for the newly issued shares to stabilize without additional selling pressure from insiders. This allows for the market to properly price the shares according to natural supply and demand. Liquidity may be thin initially, but it eventually starts to firm up with time as it establishes a trading range. Option contracts may also begin trading during the lock-up period which further allows for stability and liquidity. The lock-up period also allows for up to two consecutive earnings report releases, which provide more clarity on the business operations and outlook for investors.

IPO Lock-Up Expiration

As the lock-up expiration date nears, traders often anticipate a price drop due to the additional supply hitting the market. This can result in a rise in the short interest as traders short-sell stock into the expiration. Investors that are concerned about the upcoming lock-up expiration may try to collar or hedge their long positions with options. While stocks tend to sell-off ahead of lock-up expiration, they don't necessarily continue the selling pressure in all cases. If the pre-expiration sell-off is too dramatic, it can often cause a short squeeze on expiration day as short-sellers look to cover their shares to lock in profits or cut losses.

This is often the case when a trade gets too crowded and margin interest is exorbitant. Shares of Shake Shack Inc. (NASDAQ: SHAK) triggered a short squeeze from the day prior to its first lock-up expiration on July 28, 2015, that catapulted the stock price over 30% in less than two weeks. The margin interest had risen to over 100% to borrow shares to short.

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